Gentex (NASDAQ:GNTX) Q4 2019 Earnings Call

0:00 Ladies and gentlemen, thank you for standing by and welcome to the Gentex Report to the fourth quarter 2019 in-year and financial results. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. If you require further assistance, please press start and zero. I would now like to do a special release conference call. Mr. Josh O'Berski, you may begin.

0:18 Thank you. Good morning and welcome to the Gentex Corporation fourth quarter 2019 earnings release conference call. I'm Josh O'Berski, Gentex Director of Investor Relations, and I'm joined by Steve Downing, President and CEO, Neil Boehm, Vice President of Engineering and CTO, and Kevin Nash, Vice President of Finance and CFO. This call is live on the Internet by way of an icon on the Gentex IR website at ir.gentex.com. All contents of this conference call are the property of Gentex Corporation and may not be copied, published, reproduced, rebroadcast, retransmitted, transcribed, or otherwise redistributed. Gentex Corporation will hold responsible and liable any party for any damages incurred by Gentex Corporation with respect to any unauthorized use of the content of this conference call. This conference call contains forward-looking information within the meaning of the Gentex Safe Harbor Statement included in the Gentex Report's fourth quarter and year-end 2019 financial results press release from earlier this morning and as always shown on the Gentex website. Your participation in this conference call implies consent to these terms. Now I'll turn the call over to Steve Downing, who will give the fourth quarter 2019 financial summary. Steve?

1:29 Thank you, Josh.

1:30 For the fourth quarter of 2019, the company reported net sales of $443.8 million, a decrease of 2% compared to net sales of $453.4 million in the fourth quarter of 2018. The decrease in revenue on a quarter-over-quarter basis was due in large part to the strike at General Motors. which negatively impacted sales in the quarter by approximately 5%. In addition to the strike creating headwinds that impacted the North American market, the rest of the world light vehicle production declined 5% on a quarter over quarter basis when compared to the fourth quarter of 2018. A 6% decline in Europe and a 10% production decline in the Japan-Korea market quarter over quarter More than offset the modest improvement in the China market versus the fourth quarter of 2018. The fourth quarter has always been difficult to forecast because of inventory adjustments at our customers that often occur at year end.

2:29 But in 2019, we were also estimating the impact that the strike would have on revenue and profitability for the quarter. Throughout the year, we continue to experience exceptional growth of our full display mirror product, especially with our launch customer General Motors. By the end of the year, GM had become one of our larger customers in 2019, which means we were disproportionately impacted by the strike. For the quarter, revenue ended down 2%, but we lost approximately 5% in the revenue due to the strike. In essence, if the strike had not happened, revenue would have been up 3% for the quarter. In terms of light vehicle production, global volumes were down over 5% for the quarter, but even if you remove the impact of the strike from those numbers, then global production was still down over 4% in Q4 versus last year. This put our outperformance to market for the quarter at 7%.

3:25 For calendar year 2019, net sales increased 1% to $1.86 billion compared to $1.83 billion for calendar year 2018. Our initial sales forecast for 2019 was based on a global light vehicle production forecast that assumed an approximate growth rate of 1%. However, the actual global vehicle production rates for calendar year 2019 were down 6%, which correlates to our very strong outperformance to market of 7% for the year. The gross margin in the fourth quarter of 2019 was 36.5%, compared with a gross margin of 37.9% in the fourth quarter of 2018. The impact of the strike at General Motors caused margin headwinds of approximately 125 basis points and the resulting lost profitability during the quarter, in addition to our inability to leverage fixed overhead costs due to the lower sales.

4:23 The gross margin during the quarter was also negatively impacted by approximately 30 basis points of incremental tariffs when compared to the fourth quarter of 2018. The fourth quarter change in gross margin was driven by these two distinct situations of the strike and escalating tariff costs. that negatively impacted gross margins by 155 basis points in the quarter. Aside from these two issues, the overall gross margin would have been slightly better than last year. For calendar year 2019, the gross margin was 37%, compared with a gross margin of 37.6% for calendar year 2018. The gross margin for the year was negatively impacted by approximately 70 basis points from tariffs versus 2018.

5:09 Other factors that impacted the gross margin during the year included the company's inability to leverage fixed overhead costs on the lower than expected sales levels and annual customer price reductions that were not fully offset by purchasing cost reductions. Considering the very challenging global light vehicle production markets, the strike, and the fact that we were still dealing with some of our own product related headwinds in 2019, the team has done an excellent job of maintaining a consistent gross margin from 2018. All of our teams have been focused on offsetting annual customer price reductions, addressing incremental tariff costs, and finding ways to minimize the impact of fixed overhead pressures given the lower sales levels. The primary areas that helped bring about this improvement were better than expected purchasing cost reductions, improved manufacturing efficiencies, design changes that led to cost improvements, and the success of our full display mirror.

6:05 As we look back and compare this year to 2018, one thing is very clear. If not for the incremental tariff costs in 2019, our gross margin would have been slightly higher than it was in 2018. Operating expenses during the fourth quarter of 2019 were up 9% to $50.9 million when compared to operating expenses of $46.5 million in the fourth quarter of 2018. For calendar year 2019, operating expenses were $199.8 million up 10% compared to $182.3 million in calendar year 2018, which is in line with the company's original estimates for the year. Net income for the fourth quarter of 2019 was $99.5 million compared to net income of $106.3 million in the fourth quarter of 2018, primarily driven by the reduction in revenue as a result of the strike during the fourth quarter.

7:01 Net income for calendar year 2019 was $424.7 million, down 3%, compared with net income of $437.9 million in the calendar year 2018, primarily driven by lower vehicle production levels, increases in tariffs, and the impact of the strike. Earnings per diluted share in the fourth quarter of 2019 were $0.39, compared with earnings per diluted share of $0.41 in the fourth quarter of 2018. For calendar year 2019, earnings per diluted share were $1.66, which was a 2% increase year over year, compared with $1.62 for calendar year 2018. I will now hand the call over to Kevin for the fourth quarter financial details. Thank you, Steve.

7:45 Auto dimming mirror unit shipments increased 3% in the fourth quarter of 2019 compared with the fourth quarter of 2018. It also increased 3% for calendar year 2019 when compared to calendar year 2018. Automotive net sales in the fourth quarter of 2019 were $433.8 million, down 2% compared with $442.8 million in the fourth quarter of 2018, and for calendar year 2019 were $1.81 billion of 1% compared with $1.79 billion in calendar year 2018. Other net sales were $10 million in the fourth quarter of 2019, down 6% compared with $10.6 million in the fourth quarter of 2018, and for calendar year 19 were up 13% to $48.4 million when compared with $42.9 million in calendar 18. Now for a balance sheet update.

8:34 The following balance sheet items represent a comparison versus December 31 of 18 which are also included in today's press release. Cash and cash equivalents were $296.3 million up from $217 million primarily due to cash flow from operations and proceeds from stock option activity. which was partially offset by share repurchases, dividend payments, and capital expenditures. Short-term investments were 140.4 million, down from 169.4 million due to investment maturities, and long-term investments were 139.9 million, up slightly from 138 million. Accounts receivable was 235.4 million, up from 213.5 million, primarily due to the timing of sales in the quarter. Inventories were $248.9 million, up from $225.3 million, primarily as a result of increased raw material inventory.

9:31 Increases in raw materials are to support first quarter 2020 production and sales forecasts, as well as higher levels of component inventory with longer lead times. And accounts payable increased to $97.6 million from $92.8 million. Quickly for some cash flow highlights, the fourth quarter 2019 cash flow from operations was 122 million, down from 154.2 million in the fourth quarter of 18, driven by lower net income for the fourth quarter as a result of the strike, as well as working capital fluctuations. And for calendar year 2019, cash flow from operations was 506 million versus 552.4 million for 2018, primarily driven by decreases in net income and changes in working capital.

10:16 Capital expenditures for the fourth quarter of 2019, were $26.8 million compared with $17.2 million for the fourth quarter of 2018. And for calendar year 2019, capital expenditures were $84.6 million, which finished below our original estimates of $90 to $100 million and compared with $86 million for calendar year 2018. And depreciation and amortization for the fourth quarter of 2019 was $25.3 million compared with $21.4 million in the fourth quarter of 2018. And for calendar year 2019, depreciation and amortization was $104.7 million Thank you for joining us today. that the company maintains a broad-based stock option plan for employees as a key incentive to retain, grow, and reward them. During the fourth quarter, the market cap of the company reached all-time highs, and a result of the stock price movement was an increase in the dilution rate of the options program.

11:34 The company continues to believe that the share repurchase program that is in place currently not only offset the impact of the options program for employees, but will also have a meaningful impact in increasing shareholder return. and as of December 31 of 2019, the company has 20.1 million shares remaining available for repurchase in the previously announced plan. I'll now hand the call over to Neil for a product and CES update.

11:58 Thank you, Kevin. Earlier this month, Gemtex displayed at the 2020 Consumer Electronics Show. This show has become a preferred platform for Gemtex to showcase our technologies and capabilities. More importantly, this venue and format allows us to gauge our customers' interest in the new ideas and proof of concepts that we display, enabling us to get access to the voice of the customer quickly and with direct feedback. This year at CES was a landmark year in debuting new iterations of existing technology, completely new technology concepts and products, and even product design for a new vertical. Our first area of new product concepts was designed to show the evolution of our full display mirror. A functional prototype of a touchscreen version of our FDM was on display and included various features including pinch to zoom, tilt, pan, brightness control and the integration of soft button into the mirror display.

12:53 In terms of the soft button interface, we showed several different examples of features that could be controlled by the mirror. But as you can imagine, many of the examples centered around HomeLink and HomeLink Connect interface options. We also introduced new scene enhancement features for our full display mirror products. The first example of scene enhancement included active infrared illumination of the rearward scene to help improve visibility during nighttime driving. The second software enhancement was a lane and line projection for the FDM to assist with rearward vision by providing orientation and location of other vehicles. This feature also assists the driver or passenger in a semi-autonomous vehicle with better lane awareness and lane keeping information.

13:40 Additionally, we showed for the first time publicly a digital video recorder system implemented in a mirror. The prototype shown was very similar to an OEM sourced program that we've been in launch with for the past 12 months. This initial product combines the DVR system with our full display mirror and includes the ability to record from both a forward and rearward facing camera. The system is also designed to include removable memory and is fully designed to meet OEM specifications. Our next product area of focus was vision systems. The vision systems were shown on three separate vehicles to showcase our capabilities to engineer and provide full systems integration in any of the following scenarios. First, traditional auto dimming mirrors. Second, is a hybrid camera monitoring system solution that includes auto-dimming outside mirrors with cameras located behind the glass of each outside mirror and a third camera in the roof, chisel, or GPS antenna.

14:41 This system utilizes our full display mirror as the focal point of the digital scenes. This was showcased in our booth on both a Volvo XC90 and an Aston Martin DVS Superleggera. As announced during CES, we are working with Aston Martin to bring this hybrid CMS solution to future vehicles. The third vision system was a full CMS solution that utilizes cameras on the outside of the vehicle to replace traditional mirrors. Our version of the full CMS solution was deployed on a Cadillac CTS-V in our booth. This system included Gentex Design side view cameras and exterior pods, two interior curved OLED displays, and a third camera powering our full display mirror. Another new proof of concept shown at CES was a driver monitoring system that utilized the unique attributes of the mirror location to monitor an alert based on the driver's gaze, location of attention, and level of distraction.

15:36 Our unique location in the mirror also opens the door to incorporate full cabin monitoring solutions in the future. Utilizing our history and smoke detection systems, we displayed a new product concept that is actually a sold program to a robo taxi company. that will deploy Gentex technology in the form of a cigarette smoke or vaping sensor in an autonomous vehicle. The sensor is located in the HVAC system of the vehicle and is designed to detect and alert the robotaxi company in the event that a passenger violates the smoking policy in the autonomous vehicle. Our next focal area was a product offering that took us to a completely new geography of a vehicle as we showcased a new product concept for a B-pillar design. This external B-pillar concept incorporates one or more of the following Gentex technologies.

16:25 Dimmable glass, display technology, and cameras or sensors for personal identification. This product was conceptualized for use in an electric vehicle, rideshare vehicle, autonomous vehicle, or even a privately owned vehicle to serve as a welcome feature and to provide key information to the driver or passengers. In terms of dimmable glass, we showed several new concepts for automotives, including enhancement and further development to our sunroofs, new concepts including driver and passenger side windows, and a prototype windscreen visor concept. We also announced a new aerospace customer, and at the booth we had a functional window that we partnered with Airbus to develop. This sourcing represents our second aerospace customer and our second program where Gentex will be a Tier 1 supplier.

17:14 Our last new technology review was in the new market for Gentex. We utilized our core competencies and partnered with a world leader in medicine, the Mayo Clinic, to co-develop a cutting-edge lighting system designed to revolutionize operating room lighting. The system uses intelligence to remove glare from wet surfaces, maximize light on target areas, and remove shadows cast from people or obstacles that block the intended path of the lighting system. In terms of new product innovation and development, CES 2020 was a high watermark for the company in terms of the breadth and depth of the technology offering and we're excited to see how these products resonate with our customers over the next two to three years. I'll now hand the call back over to Steve for 2020 and 2021 guidance and closing remarks.

18:01 Thanks, Neil. Our forecasted guidance for calendar years 2020 and 2021 are based on the mid-January 2020 IHS market production forecast for light vehicles produced in North America, Europe, Japan, Korea, and China. The current IHS market light vehicle production forecast for these markets is expected to decrease approximately 1% for 2020 with a 1% increase currently forecasted for 2021. Based on the current 2020 vehicle production forecast, the company estimates that net sales for the calendar year 2020 will be between $1.91 and $2 billion. The company also estimates that the gross profit margin for calendar year 2020 will be between 36 and 37%.

18:49 The gross margin estimate includes approximately $20 million in annual costs as a result of tariffs that were put in place beginning in 2018 and that have continued to increase throughout 2019. The company has worked hard to mitigate the escalation of tariffs by significantly reducing our exposure. However, this still remains a meaningful cost both on imports of raw materials as well as on products sold into the China market. The company estimates that operating expenses will be between $205 and $215 million for 2020. We continue to invest heavily in technology as we fund the development of our current product portfolio and create iterations of those products that help keep these products new and attractive to our customers.

19:34 We have also been investing heavily in the next wave of innovation, many of which were shown for the first time at CES this month and included new products for automotive, aerospace, and our newest developments in intelligent medical lighting. The company currently is estimating its annual effective tax rate to be between 15% and 17% for calendar year 2020. Variation in the tax rate will occur from time to time. and these are driven primarily by the impact of the FDII calculation, R&D tax credits, state tax rates, as well as discrete benefits related to stock-based compensation. Over the last several years, the company has been more disciplined about spending capital appropriately based on the overall business need, the forecast for future growth, economic conditions and upcoming product launches and we will continue to manage the business in this manner. Based on that, the company estimates that capital expenditures for 2020 will be between $85 and $95 million, and that depreciation and amortization expense will be between $105 and $110 million for calendar year 2020.

20:40 Based on the mid-January 2020 IHS market forecast for light vehicle production for calendar year 2021, the company currently expects 2021 revenue growth of approximately 3 to 8% above the 2020 revenue estimates. While the current forecast for global light vehicle production appears to be stabilizing, it certainly does not provide any tailwinds to our growth rate in 2020 or 2021. Additionally, although there have been some improvements in global trade relations, tariffs still remain on incoming materials and on our exports into the China market, which create headwinds to growth in the domestic China market and to the profitability of many of our products. So while the underlying market conditions continue to be difficult, we are optimistic about our ability to continue the trend of outgrowth versus the market for 2020 and 2021 based on our targeted growth rate of 3% to 8% per year. This growth rate will be driven by increased penetration rates of our core mirror products, continued growth of our full display mirror product, and launches of the new integrated full module product.

21:46 The company remains committed to investing heavily in new technology in the area of vision systems, connected car, and dimmable glass. As we look back on 2019, the industry will remember a year categorized and defined by global vehicle production declines of over 6%, a strike that caused large disruptions and inefficiencies, trade wars that created product availability concerns and cost pressures. At Gentex, what we will remember is that we found a way to grow despite industry headwinds that we stabilized our gross margin despite tariffs and supply constraints, that we grew EPS for our shareholders, all while innovating and creating new products at the fastest pace in company history. We learned a lot during 2019. And we are hopeful that perhaps 2020 will be a slightly better environment to operate in. But regardless of the backdrop, we are confident in our technology offering and the capability of our team to create growth and shareholder returns for years to come. Thank you for your time today, and we can now proceed to questions.

22:49 Ladies and gentlemen, if you have a question or a comment at this time, please press the star, then the one key on your touch-tone telephone. If your question has been answered, you wish to move yourself from the queue, please press the pound key. Our first question comes from Chris Van Horn with B. Riley FBR. Good morning. Thanks for taking my call.

23:05 Thanks, Chris.

23:07 So I just want to focus on CF, because you had a lot going on there. You showed a lot of new product. and in years past, you know, you've shown, you know, kind of revolutionary products, if you will, for the auto space and then you start to get awards and see those come to market, you know, in the following 12 to 18 months. So I'm just wondering, you know, you had the CMS award this year and you showed a lot of new things around full display mirror. Could you get in more detail about what the pipeline looks like for some of those automotive related products and maybe some more detail on our timing?

23:41 Sure. So what was really unique about 2020 CES this year was a lot, like you mentioned, a lot of times when we show something at CES, even this year we did it too. And there were two products in particular that we showed for the first time publicly, but we already had source programs for. And that would have been the smoke vape sensor and also the DVR product. So those, even though they're brand new products and we haven't really shown them to a lot of customers, those were actually co-developed with OEMs. So Those are already in line in launch phase, so those should be producing revenue in the next two to three years. If you look beyond that, and CMS as well is something that we obviously partnered with on Aston Martin, but we continue to show full capability in that product lineup. That one we would expect to take a little longer, and the reason why is OEM has to make a strategic decision about how do they want to execute, do they want to execute a CMS type product, and then if so, what does that design phase need to look like? Some of those products are further out, probably three to five years out before they'll generate revenue.

24:42 Some of them are here and now, and then obviously some of them, like the new product on the medical lighting side, we think that's a two- to three-year development to finish up that development and get it ready for launch.

24:54 Okay, great. And then, you know, kind of sticking with CES, you know, on the aerospace side, obviously, you know, big win with Airbus, But you also showed some other technologies. And I'm wondering, was that OEM driven? You know, was it Boeing or Airbus or even a business jet driven decision to go down that product route? Or because you were developing other products for the aerospace market, you said, look, we've got some things we can kind of transfer over there.

25:20 And now you're going to go to market with those. Yeah, there were multiple other technologies that we demonstrated between the smart lighting for beyond the medical, but for aerospace as well as some of the sensing systems. And those are more utilizing some of our core competencies and demonstrating what could be done into that aerospace market. So more driven actually through customer interest and then combining that with our capability. There was the I'll call it the two-way mirror that we also demonstrated, which was a reflective surface just like our full display mirror that had displays behind it. That was actually an interest from an OEM, from an aerospace OEM that we worked with to develop the concept and then are trying to work further to enhance that and get that ready from an award perspective.

26:09 I think the interesting thing there is What we found with our aerospace customers, once we get down the product path and we're developing our window capability with them, what they start to see is the other things that we do at Genpex. And so the interest wasn't necessarily specific to, hey, show us these products. It was more about we love the fact that Genpex comes in with unique concepts and is somewhat disruptive in the space. our goal on the aerospace show and then at CES was to show some of those disruptive concepts and then to really start to put the technology foot forward beyond just dimmable glass but into other areas that we feel we have capabilities in for aerospace.

26:48 Okay, great. And then lastly for me, obviously the mirror shipments for full display mirror in 2019 was well above expectations. Any sense on how that any sort of visibility on how that number might evolve over 2021 and 2022 or even 2020 as well.

27:07 Yeah, I think if you look at the last three years, kind of the growth rate and you kind of average that growth rate out and then cast that forward, that's kind of what our expectations look like over the next couple of years from a growth rate perspective. You know, we definitely, this year was a big step up. So we're not saying it's going to be the same number of units. But if you look at that average over three years, we think that's a pretty good indication of where it should be in over the next two to three years. Okay, got it. Thanks so much for the time. Thanks, Chris. Our next question comes from James Piccirillo of KeyBank.

27:42 Hey, good morning, guys. Morning. For FDM, how many nameplates do you expect to be on by the end of 2020? And with how many OEMs? I believe the numbers for 2019 were five OEs across 38 nameplates. Is that right?

27:59 That was what was shipping, our estimated...

28:02 I think over the next, over 2020, I want to say that we're adding, we should be shipping on an additional two, is it two or three OEMs we had this year? I think we had two or three OEMs this year. And I don't want to guess the number of nameplates, quite frankly, just because I don't have it in front of me. But two to three OEMs should launch this year. And then obviously we'll see some propagation of additional nameplates, not only on those OEMs, but on our existing OEMs as well.

28:28 Okay, and if you do give us a unit volume estimate for 2020, we'll just add 200,000 units to that, whatever number, the real forecast.

28:39 Well, we were joking ahead of the call that what we're going to say about that, and Kevin thought it would be a good idea if I went with my at least half a million units again. Yeah.

28:49 No, if we just think about maybe, you know, you obviously have your 2020 guidance out, but, like, just sticking out to 2021, like, let's say – Most reasonable scenario that allows Gentex to really start to deliver margin improvement again. What pieces get the company back on track for that to happen?

29:13 Yeah, I think first and foremost, one of the things we've been fighting through and we've been talking about quite a bit are the headwinds to our revenue. We had some legacy products that have been causing headwinds on the revenue side, and obviously that hurts on overall overhead exposure. Stability in vehicle production would be perfect. We don't need massive growth in the number of vehicles produced, but 6% headwind of vehicles produced is obviously problematic. As you look beyond that, you start talking about tariffs and things that actually directly impact gross margin. Some stability in terms of trade relations, even a wind down or pull back in those would be incredibly helpful. Beyond that, it's about execution. Getting that growth rate above 5%, is really where we start to see margin expansion.

29:56 Got it. That's helpful. And then just what are you baking in for 2020 in terms of incremental tariff impact?

30:03 Well, this year was about $17.5 million, and what we had talked about on the prepared comments is right now we have about $20 million baked into the forecast. The 17 and a half is a cumulative all-in number as opposed to incremental for 19? Yeah, that was the total for 19. Yeah.

30:20 And then we're estimating 20. Yeah, the reason why we're estimating a little higher is because if you look at the second half of 19, there were increases in the tariffs mid-19, I think May and June. And so the second half run rate was a hair higher than the first half run rate. Got it. Thanks, guys. Thank you. Our next question comes from David Kelly with Jefferies.

30:45 Good morning, guys. Appreciate you taking my questions. I guess you mentioned the legacy revenue headwinds. Could you update us on what the full year 2019 impact of SmartBeam and Driver Assist was? And then any color on how you're thinking about 2020 and the update on the timing of the Mobileye roll-off would be really helpful.

31:09 Yep. Good question. For 2019, it actually was about 275 basis points of headwind. Two-thirds of that was Mobileye, the other third probably SmartBeam. And for 2020, we're looking at probably another 150 to 200 basis points of headwind. And then one more year, really, of impact in 2021, probably closer to 75 to 100 basis points. and then we'll be done talking about it, hopefully. Okay, and that fall off in 2021 is the last bit of Mobileye.

31:45 Okay, perfect. That answers my question. And then I guess, you know, maybe switching gears a bit. I mean, I think this sounds good. Another busy earnings week. So the revenue guidance assumptions, I mean, I think most – to date at least are assuming global light vehicle production may be a bit worse than IHS somewhere around the number seems to be minus two to minus four. Are you planning for anything as it relates to 2020 some downside to that minus one that could be embedded in that revenue guidance as well or is this market specific or something you're seeing on the horizon that maybe might provide some upside versus what some of the others are thinking out there?

32:30 Yeah, I think, you know, given what's happened in the last two years in particular, we tend to have a little bit of a negative slant on the IHS estimates, generically, not just in 2020. So, you know, our model, when we look at it, we're probably a little more pessimistic than what those numbers suggest, especially given what's going on in China right now, knowing that their shutdowns are happening due to the virus, and there's probably a couple weeks of exposure there if that continues. So, Not that we would be disproportionately impacted based on changes in China, but it definitely does affect where we've been growing over the last couple years. So we do have to keep our eye on that. Beyond that, what we're hopeful for is that if the market's just stable, even if it's slightly down, but stable, that gives us a great platform to operate in. The tough part is when you talk about strikes and some of the other inefficiencies that have happened, it's really tough to plan, and it's very difficult, obviously, to get efficiencies when you're turning on and turning off lines. And so one of the things that we're focused on and hopeful for is that even if the numbers aren't perfect, at least it'll be a more stable environment to operate.

33:37 Great, great. Really appreciate the color. Thank you. Thank you. Our next question comes from David Lecker with Bayard. Good morning.

33:48 Good morning, David. Good morning, David. I was wondering, well, first of all, these year-end adjustments to inventory, I presume most of that is with the business that you have as Tier 2 supplier, is that correct?

34:02 Yeah, most of it's with our Tier 1 customers, yep.

34:07 And can you quantify it at all, how big of a number that was?

34:11 It wasn't as big this year. I mean, it wasn't a huge problem. It was more about the biggest impact was the strike in Q4.

34:19 Okay, great. and then I want to circle back a bit on the commentary about the new launches and what 2021-22 might look like. Is there any sense, you know, is there any choppiness in any of that or does it look like your launches here are going to be fairly even as they come online the next couple of years?

34:42 Are you talking specifically about FDM or generically?

34:46 FDM.

34:47 No, I don't think there'll be a lot of lumpiness. I mean, I think it'll be pretty well, pretty spread out throughout the year.

34:56 How close is GM to being fully launched with your product?

35:00 I would say, I'm trying to put in a percentage. I would guess they're probably about 80% of the way there in terms of number of vehicles and nameplates. Obviously, over the next couple of years, you'll have some of those nameplates that we launched on a few years ago start to roll off and become new vehicles. So you'll see what would look like a loss as they design a vehicle and replace it with something else. But right now, we feel really comfortable about where we're at with that GM launch. Now, it's less about the number of vehicles you're on. Right now, it's about take rates and penetration of that product into the GM lineup.

35:33 You stole my next question. Okay. I'm guessing you're seeing take rates at GM of those products, those vehicles that have launched that you're continuing to see take rates there. What kind of take rates are you seeing on the vehicles that you have FDM on?

35:48 Depends on which level of vehicle. Obviously in some of the vehicles like the Cadillac lineup you're seeing upwards in the high 90s and then if you're in more of the volume vehicles you're in the mid 20s to mid 30% range.

36:03 Is that consistent across other customers or is that

36:08 That was really high at GM. If you look at Land Rover, for instance, we do very well on Land Rover vehicles. I would say probably in the 70-80% range is kind of where we're at on the Land Rover lineup. Beyond that, it depends on the OEM and their strategy and which vehicle it is. But I would say on average, when we get a customer, we kind of expect to be somewhere in the 30-40% range is kind of a good rule of thumb.

36:35 Okay. That's all that I really wanted to take through. Thank you.

36:41 Thank you. Thanks, David.

36:42 Thank you. Our next question comes from John Murphy with Bank of America.

36:48 Good morning, guys. Good morning, John. Just wanted to sort of think about the 2020 guide here. I mean, you're looking for revenue up about 5% at the midpoint. I mean, should we think about units growing at the same rate? or could they actually grow a little bit faster and some of these legacy products just create a little bit more pressure on revenue from here? I'm just trying to understand how you're thinking about the revenue of the units for next year.

37:12 Actually, I think, you know, given the headwinds on the production side and our kind of take on that, we wouldn't expect units to be above revenue. We actually think that with the growth in FDM, you're going to continue to see kind of dollar content increase on that side. And so we think, you know, units will probably be a little lower growth rate than revenue.

37:32 Okay, and maybe just to follow up on that, when we looked at the fourth quarter, I mean, the revenue premier when you simply take automotive revenue divided by the total shipments was, I think, down about 5%. I mean, does that have a lot to do with the GM strike and it's sort of an anomaly? Or is there something else going on there on legacy products below this?

37:54 It was primarily due to GM, because if you think about them as a content, FDM is a big part of it, Homelink, which is not included in that number. at the modular base. But then secondarily, the driver assist, primarily Mobileye, as it's one of our higher ASP products. So the combination of both of those drove the ASP decline.

38:13 Well, and the other thing I would add there is OEC growth rate in the quarter was very high. And so those are below average ASP. And so whenever you have OEC growth rates much higher than IEC growth rates, you're going to see ASP deterioration. But like we always talk about, that tends to be a good signal for long-term for margin stability.

38:34 Got it. And that actually leads to my next question on the gross margins. I mean, basically looking for flat to down year-over-year tariffs, you're highlighting as a headwind. Is there any Anything else that would be sort of a weight? I mean, with that kind of revenue growth, you'd expect there to be some pretty good gross margin uplift.

38:51 Yeah, I think just in general, you have normal annual customer price reductions and what we know to be a little tougher market from a supply standpoint to get cost reductions out of supply base. But the biggest factor you point out there are the tariffs and what we're seeing as we grow in China, for instance, and those tariffs on our products that we export into China. do drive that as tariff costs higher. Not only the thing we always end up talking about is the incoming. We talk about a lot from the supply community. But for us, you know, about half of those tariffs are on our exports back into the China market. So as we hopefully will see a rebound in the China production levels, we would expect those tariffs to move proportionally with that, what we hope to be a growth rate back into China.

39:33 Got it. That's helpful. And then as we think about sort of the adjacency of the Airbus windows as well as what you're working on the Mayo Clinic with the operating room lighting. Do any of those roll on in the 2021 timeframe or are these really sort of two to five years out? And how should we think about the revenue and gross margin opportunity there?

39:55 Yeah, from the timing side, the aerospace window side will start rolling in beginning part of next year. And then we'll talk about the medical lighting. That's That's two to three years of development, and then you're probably closer to four to five years out before that would actually contribute anything.

40:14 Got it. And the economics on both of those, as far as margins, I would imagine would be significantly higher than your corporate average. Is that a fair statement? That's the hope. Okay. Then just lastly on the CapEx, I mean, what has happened here? I mean, it seems like you guys are executing and putting in lines and everything that you need. I mean, was there something going on in the past where there was sort of a slight lack of discipline in capex spending, or is there something else that you're kind of, you know, secret sauce you're uncovering here as you're being a lot more efficient?

40:46 Yeah, I think there's a combination. I think one of the things we've worked really hard on as a management team the last few years is making sure we're planning out further. That allows you to spend more efficiently. You're not rushing the buildings, facilities, and lines in place. Some of it is us just trying to manage to the market that we're in and being cognizant of what's happening from a growth rate perspective, knowing that if we want to protect margins, we got to also protect for overhead issues. And those overhead issues are compounded when you have lower growth rate periods. And so fortunately, the last few years, we've been focused on that. That allowed us to have quite a bit of margin stability this year, whereas if we had overspent with a low single-digit growth rate, it would have been really difficult to absorb that extra overhead. So part of it is being disciplined.

41:34 Part of it is, I don't want to say necessarily there was a lack of discipline before, but there was definitely some things that we looked at and said we should be able to do better than that. And so we've been focused on that as a team for the last couple years, and now it's become part of our DNA. Great. That's awesome. Thank you very much. Thank you. My next question comes from Ryan Brickman with J.P. Morgan. Hi, thanks for taking my questions.

41:58 Maybe just to start with another one, hi, on the new medical business that you're pursuing, how are you thinking about the various use cases for the product and how are you thinking about the associated total addressable market to the extent that you've done that work in GenShare?

42:13 Yeah, so what was interesting about the product concept and the partnership with Mayo was It was focused on a problem statement that they had been working on and trying to solve for a long time, which was a general lack of technology, intelligence, the ability for surgeons and operating room staff to really execute well in that environment. Obviously, our history with machine vision and control and lighting and automotive was a good building block that we began with and started to make enhancements to that product. The real use case there, the available market there is obviously a number of operating rooms. The system itself is scalable. In other words, they're kind of pods that you can put. They're ceiling mounted, flush with the ceiling, so you can scale based off of the need of that operating room. In terms of one of the things that we're excited about longer term is with the machine and the intelligence system, you can go to a fewer number of lighting pods and start to address not only operating rooms, but general care facilities, dentist's office to orthodontist, doctor's offices, etc. there's a lot of available market outside of just the traditional operating room. And so when we look at the scalability of this system, we think there's plenty of market available we know there's a lot of work to do to get this through not only the development phase to make sure it works as well as we think it should but then also through the clinical trial process and then also FDA approvals but when you start talking about all those steps that's where we come up with that three to five year kind of window but we at this point in the development phase a couple years into this we don't see any reason why we can't go ahead and complete that development

43:46 cycle all the technical hurdles that we saw at the beginning we've gotten through most of those we know there'll be a lot more as we continue that evolution and development but it's pretty exciting because it is a very scalable system and you can literally go from one or two pods up to 10 or 12 per room depending on the need.

44:04 Okay thanks and then you know when it comes to the development cost to support the medical business or the vape sensor the new camera monitoring systems etc you know to what extent have these costs already been running through your ER&D line and then as a follow-up I'm not sure how much you can or want to disclose but Are there other kind of like left field things that you are working on that are also already reflected in current ER&D that we don't yet know about similar to the medical revelation? You know, what percent of your ER&D would you say is associated with new automotive and non automotive product categories that you're not already in today?

44:40 Sure. So I would say, you know, the vast majority of the cost increases that we've been talking about over the last two years and step up in R&D spending. Those are already running through. On the medical, supporting aerospace and medical, I'd say we're 80% of that already. In other words, there might be some small increases to that that would drive R&D higher as we move through these next couple years. But this isn't like this is going to double R&D spend or even be a huge mover to that. It's already reflected in our current spend. And to answer your question on the other, yeah, there's always some crazy ideas that we're working on that are pretty far out there. that are already in the budget as well. We usually don't talk about them until we feel like we have a market or a partner or a customer. And the reason why is, you know, the vast majority of these ideas end up kind of failing or evolving and becoming something different.

45:30 This one on the medical side, we felt really good about where we were with our partnership with Mayo and the relationship that we've developed with them. and we felt like it was the right time to kind of show that to help kind of get the market aware of what we're working on and what we think could be coming down the pike in the next couple years.

45:46 Got it. Thanks. And then just lastly from me, you know, you mentioned that you're basing your outlook for global light vehicle production minus 1% upon IHS. I know that's consistent with your historical practice. A few suppliers earlier this week, though, assumed global production more like minus 3% in 2020, a bit below IHS. I'm just curious how you're thinking about the trend in global production this year. Do you think there's, you know, upside or downside to various regions and maybe just what the latest you're seeing on the ground in China is?

46:13 Yeah, I'd say, I mean, we would tend to agree with that, that there's probably more downside risks than upside potential. And so we kind of build our forecast around that, looking at, you know, you go through some situational conditioning and look at it and say, okay, what is it, you know, what if it's down an extra percent or two and what does our forecast look like? We believe that our guidance range encapsulates a couple points, a point or two more of downside. Obviously, we would love to see it just stable or flat or even a slight uptick, but we're not necessarily dependent on that, depending on where those headwinds or uplifts come from. It may or may not help us. I mean, we are very geographically, you know, kind of nuanced. So you got to be careful of just looking at vehicle production. What we look at is where are we growing the most in those primary markets, especially the more mature markets where average vehicle sale prices are higher.

47:05 And then also looking at, you know, what segmentation of vehicles those headwinds or challenges are coming from. if it's coming from eight segment vehicles, it's probably not gonna impact us as much. If it's C, D, and E, obviously we're gonna have a disproportionate exposure to those level of vehicles.

47:22 I see, thank you. Thanks Ryan. Thanks Ryan. Our next question comes from David Wexton with Morningstar.

47:30 Thanks, good morning. Hi David. Kevin, I think earlier you were talking about inventory for the higher raw materials due to some longer lead time. products coming and also some higher production coming, if I heard right. Are you able to be a bit more specific as to what those products are and what customers at the higher production?

47:52 Not from a customer perspective, but it's really the general statement around FDM and the cost of the components related to FDM displays, electronics, all the things associated with that and building up for what was a shortfall in Q4. because of the strike and then the build back and what we're seeing kind of going into Q1.

48:12 And to put you as an example, like in LCG right now, you're talking about months of lead time to get those components. So when the strike happened and it happened that quickly, we've already got the components on site in order to support our customers, but then it comes with zero sales for five weeks. So obviously your inventory starts to change pretty quickly when that happens.

48:33 Okay. We had a little bit of thawing in U.S.-China trade relations recently. I know you talked about a dollar tariff headwind, but I missed the first minute of the call, so I apologize if you mentioned this, but anything you can say on basis points impact? I know you talked about 110 bits before.

48:56 That's kind of where we're at. All in is around 100 basis points of total exposure in 2019. We're modeling in about $20 million worth of impact for 2020. which is around the same impact. Now, as Steve also mentioned, if things grow in China, which we hope, the tariffs actually do incrementally get a little bit worse versus what the mix was in 2019 because of all of our imports into the China market. Our tariff rates there are, at this point, about half of what the total tariff exposure is.

49:28 Okay. Thanks, guys. Thanks, Dave. Appreciate it. Thanks, Dave. Our next question comes from Ryan Sigdahl with Craig Callum Capital.

49:37 Hey guys, as it relates to the virus-related disruptions going on in China here, have you guys seen any impact to either component supply into the U.S. or shipments into China?

49:52 Yeah, not so much on our shipments into China, but on the incoming supply side, you definitely see some things happening there. I mean, nothing that's catastrophic like it was during the natural disasters from a few years ago, but more problems just getting components A on time. Definitely, especially during some of the trade disputes, there was some slowdown in the processing at ports and how things were happening, so something we were keeping our eye on. More importantly for us, in order to offset a lot of those tariffs, we've had some change in supplier locations and ultimately some change in suppliers to help find areas where we could get sourced outside of those areas that would be impacted by tariffs. Some of it was things that happened to us. Some of it were things we were actively trying to pursue in order to get costs down.

50:38 Those continue to happen. They're definitely not as bad right now as what they have been. We continue to watch it and you're always a little careful to You count your chickens. You're just nervous that somehow something changes and that there's a disruption. And given the complexity of our industry and the supply base, it's something we always keep our eye on.

50:58 And as you talk about moving suppliers and locations, is that primarily to other regions in China or is that outside of the country? And then secondly, you mentioned that you talked about kind of higher lead time for building some inventory components, but Is there anything related to kind of the situation in China and why you're also building some inventory of components there?

51:18 No, nothing that's going on in China that's causing that build and inventory. It was really there was a lot of components that come from China that we use in FDM products, for instance, and some of our other products. that as the strike happened, you know, we needed to have those parts in order in the late fall in order to have them here, you know, oftentimes 12 to 16 weeks ahead of when you owe those deliveries to your customer. And so we have those parts already in house and already coming. and then when you have five weeks stoppage of parts you're selling to your customer, you see the inventory level swell and you're not stopping the incoming supply very much because you know you have to ramp back up or be prepared to ramp back up late fourth quarter or early Q1 to help support your customers. So that's what's really driving that increase in inventory.

52:06 And then you had a second part of that question. Oh yeah, the other part is The vast majority of those when we moved were changing either the existing supplier to a different location they had outside of China in order to get away from the terrorist situation. In some cases, actually changing the sourcing to a different supplier outside of China.

52:26 Got it. Last one for me, and maybe I missed it earlier, but did you guys give the new nameplate launches you had in the quarter like you normally do, and then also within that kind of a breakout between advanced features, geographic regions, products, etc.? ?

52:40 No, we didn't go through it. Just Neil's section was long enough and he was about ready to pass out after covering all that. So we decided to give him a break. But basically the launches for full display mirror and Q4 were right in line with what our estimates were. So there's a couple of them we didn't, we weren't going to mention by name because they haven't shown up on the customer's websites yet or they haven't made an announcement of them. But we've gone through our launch phase and have begun the shipping process. It just hasn't hit the marketplace yet.

53:09 Got it. And then everything else, fair to say it's, you know, reasonably in line with kind of similar quarters previously or was there?

53:15 Yeah, yeah, exactly. The normal kind of product launches, you know, usually somewhere above 50% of the product launches we do are some type of an advanced feature. Continued growth and even despite the things that are going on, continued growth in China and market for us with our base mirror applications. So all in all, pretty similar quarter to what we've had in the past.

53:38 Great. That's it for me. Good luck, guys. Thank you very much. Thanks. I'm not showing any further questions at this time. I'd like to turn the call back over to our host.

53:47 Great. Thank you, everyone, for your time and questions. This concludes our call. Have a great weekend. Ladies and gentlemen, this concludes today's presentation. You may now disconnect and have a wonderful day.